China to Further Regulate Equity Investment in Pilot Areas

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Mar. 1 – China recently promulgated an official document, intending to better regulate the filing and expansion of equity investment enterprises (EIEs). The country has been practicing the filing system of EIEs as an experiment in the Yangtze River Delta since June 2008, as well as in several development zones in Tianjin, Beijing and Wuhan.

The “Circular to Further Regulate the Development and Filing Management of EIEs (fagaibancaijin [2011] No. 253)” by the National Development and Reform Commission (NDRC) on January 31, 2011 imposed stricter restrictions on capital raising avenues as well as the investment scopes of EIEs; requiring a more efficient system of risk control, information release, and record keeping as well as clarification of the basic responsibilities of equity investment management institutes (EIMIs).

The establishment, capital raising and investment scope of EIEs
The establishment of EIEs shall comply with the “Company Law of Peoples Republic of China (PRC)” and “Partnership Enterprise Law of PRC.” EIEs in the form of a limited corporation or stock corporation can either conduct self-management or commission other EIEs or EIMIs for asset management.

The Circular forbade EIEs to raise funds publicly. Instead, they can only privately raise funds from specific investors who can identify and afford risks. Those specific investors are only allowed to use self-occupied funds for subscribed capital.

The investment scope is limited in enterprise equity that is not for public exchange. The idle funds during investment shall only be placed as bank deposit or invested on fixed-income investment products such as government bonds. All the invested projects shall comply with related national policies, obtain approval and go through review and filing procedures.

The risk control system
EIEs shall reduce risks by diversifying their capital allocation. They are forbidden to be the guarantees of any enterprises except for ones that they have invested in. Related parities that EIEs invest on shall avoid their involvement in investment strategy-making.

The Circular clarifies that when an EIMI commissioned by EIEs is a wholly foreign-owned enterprise or joint venture, it has to boast legal personality to function as a custodian.

The basic responsibilities of EIMIs
The major responsibilities of an EIMI as an EIE custodian include:

  • Plan and implement an investment, and conduct post-investment management of the invested-enterprise
  • Participate in development strategy making for the invested enterprise, and provide value-added services
  • Provide investment and operation information of the invested enterprises (including a financial statement audited by a third party) to the EIEs on either a regular or irregular basis
  • Other responsibilities that the commission contract includes

The Circular expressed special concern over EIMIs’ inappropriate use of EIEs’ assets in the custody. It stipulates that an EIMI shall set up separate accounts for every EIE under its management.

Information disclosure system
In addition to disclosing investment operation information to investors according to the contracts, an EIE shall also submit an annual business report and financial statement audited by certified public accountants to the NDRC as well as the local filing assistance authorities within four months after every fiscal year ends. An EIMI is also obligated to provide an annual asset management and asset custody report to the aforementioned authorities during the same period of a year.

The filing of EIEs
Every registered EIE in pilot areas shall be filed for management at the NDRC except for the following types of EIEs:

  • Venture capital enterprises that have already been filed according to the “interim measures on venture capital enterprise management” issued in 2005
  • EIEs with capital scale of less than RMB500 million or same amount of foreign currency
  • EIEs whose capital comes from only one institute, one natural person or multi investors that belong to a subsidiary wholly-owned by one institute

The Circular clarified that an EIMI that functions as an EIE custodian shall also be filed for record.

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